When it comes to the market, there is one cold, stark reality: any investment is a risky one. Granted, you could choose to invest solely in U.S. Treasurys, which are the world’s safest investment, but that certainly won’t make you rich or provide fully for your retirement.
The truth is, if you want a decent return, you will have to deal with a bit of risk. There is a spectrum of risk and return for various assets in the market. On one end, you have stocks, options, and futures, which offer the highest returns (typically) with some of the highest risk. On the other end, you have U.S. Treasurys and other government bonds, which are backed by the full faith and credit of the United States of America but offer small returns.
Mutual funds can be placed at virtually any place along the spectrum, all based on the riskiness of the underlying asset that the fund represents. Stock mutual funds are riskier than bond mutual funds, for example. To say that a mutual fund is ’safe’, then, is not necessarily true. When compared to just buying individual stocks, though, most mutual funds do not carry as much risk.
To find the best mutual fund investments for safety, then, you have to know a bit about the underlying assets that funds represent, what risk and return they carry, and how you can find these mutual funds and make use of the min your portfolio.
Assessing Mutual Fund Types
Stock Mutual Funds
The most popular type of mutual fund is a stock mutual fund or equity mutual fund. These funds contain shares of many different stocks. Even within this category, there is a spectrum. A stock fund that invests in just one sector carries more risk than a fund that invests in, say, five different sectors (because the risk is spread out). A stock fund that invests in solid, large-cap, blue-chip companies carries less risk than a fund that invests in smaller, less well-known, and less stable companies.
One way to find safer stock funds is to find funds that invest in stocks with low beta. Beta, or the beta coefficient, is a number that determines how volatile the stock is compared to the rest of the market. A stock with a beta of 1.0 is in equilibrium with the market; it fluctuates in price roughly the same as the market does. A stock with a low beta, then, is considered less risky because it is less volatile. Its price does not rise – or fall – nearly as much as other stocks. Also, if the stock’s beta is positive, it appreciates when the market does; if it is negative, its performance is opposite that of the market.
Bond Mutual Funds
Another type is a bond mutual fund. This type invests in bonds, which are basically IOUs from corporations and governments that come with a given interest rate and a price due to the holder of the bond when the bond matures. Bonds are typically negatively correlated with stocks. In other words, when stocks are performing well, bonds usually aren’t; when bonds are strong, stocks are weak.
A bond mutual fund contains several different bonds. The Oppenheimer Champion Income Fund A (OPCHX) is an example of a bond mutual fund. This particular fund holds corporate bonds and foreign bonds in addition to a small amount of stocks, cash, and other assets.
You can use some of the same measures to determine the risk of a bond mutual fund. For example, the beta of OPCHX is -0.42. This means that the bond generally performs opposite of the market’s performance, and does not fluctuate as much as the market does.
You can also use something called a fixed-income style box. This is a chart created by Morningstar that gives you an at-a-glance idea of a bond’s risk and return. The style chart for OPCHX is here; it is the black-and-white, nine-square box in the middle of the page. You can see that the sensitivity of the bond to interest rates is moderate (bonds are sensitive to interest rates, which is a key risk), and that the quality of the bonds held by the fund are low. The lower the quality (as determined by the bond’s rating), the higher the return – and risk.
Money Market Funds
Finally, you can find money market funds, funds that invest in the money markets that contain corporate and government debt securities. These include U.S. Treasurys (Notes, Bills, and Bonds), which are the safest investment assets in the world. As you can imagine, money market funds generally are the safest mutual fund investments you can make, primarily because most government, municipal, and corporate bonds, bills, notes, and other debt obligations are pretty sound.
For example, the Vanguard Prime Money Market Fund (VMMXX) is a money market fund that invests in 471 holdings. Close to 33% of these holdings – or 155 holdings – are U.S. Treasury Bills. Close to 8.5% is invested in corporate paper, which are generally very sound and relatively free from default (usually you see corporate paper from reputable corporations, not unstable ones).
Returns aren’t great; since VMMXX’s inception in 1976, it has returned just 5.75%. It’s 10-year return is 1.91%, which is higher than the average of 1.46%. But, the risk is far lower than other assets, too.
What are the Safest Mutual Funds?
Most in the field will tell you that the safest mutual funds you can find are money market funds, primarily those that invest heavily in U.S. Government debt. No one anticipates that the United States will ever default and go bankrupt, and virtually everyone assumes that American credit will be relatively strong for the foreseeable future. That is why countries continually purchase billions of dollars worth of federal debt; they anticipate a return that is virtually guaranteed.
You can benefit from this by turning to money market funds for a safe, (relatively) risk-free investment.